THE WALL STREET TRANSCRIPT

 

Questioning Market Leaders For Long Term Investors


WILLIAM GAMMELL - CAIRN ENERGY PLC (CNE.L)
CEO Interview - published 06/20/00

DOCUMENT # KAF006

WILLIAM GAMMELL is the Chief Executive Officer of Cairn Energy Plc. Mr Gammell trained with Arthur Young McLelland Moores. He founded his own company, Cairn Energy Management Ltd in 1980. Cairn Energy Management Ltd was acquired by Caledonian Offshore Ltd in 1988 and renamed Cairn Energy Plc. Cairn received a full Stock Exchange Listing in 1989. Cairn Energy Plc is an international oil and gas company whose key producing interests are in Bangladesh and India. Bill was born in 1952 and is married with two sons. His principal leisure interests are skiing, football and rugby (ex-Scottish International). He is a Director of the Scottish Institute of Sport, a founder member of the Entrepreneurial Exchange and a member of the Edinburgh and Leith Petroleum Club where he was President in 1992/93.

Sector: Energy

TWST: Could we start with a brief overview of Cairn Energy: the company's history, activities and developments?

Mr. Gammell: Cairn Energy originated in the early 1980s. In the late 1980s, we got a London Stock Exchange listing. And between 1989 and 1992, our primary focus was the US Gulf of Mexico. We subsequently floated out our interests in the US, with a company called Cairn Energy USA, which was subsequently floated on NASDAQ. The prime focus of the company for the last seven years or so has been the Indian subcontinent. Cairn currently produces approximately 8% of India's oil production, and, until recently, was the operator of the Sangu gas field in Bangladesh, which produces about 15% of Bangladesh's gas production. We have a 50-50 joint venture with Shell in Bangladesh, and they are now the operator of that field. We have broadly 100 million barrels of reserves at last year-end. Our producing fields are the Sangu gas field in Bangladesh, the Ravva field in India, and then we have some interest in the North Sea, the Gryphon oil field and Markham in the Dutch North Sea. However, we are driven as an exploration company with a very solid balance sheet. In fact, we currently have no debt, and we are producing in the order of 22,000 barrels of oil a day.

TWST: I understand that you announced a significant gas discovery in May.

Mr. Gammell: Yes, that's right. The vision that we have for the company is to build substantial positions in areas that we think have high exploration potential. And philosophically, we try to create new value, rather than follow a bandwagon. In Bangladesh, we made the first offshore discovery at Sangu in India, following our acquisition of Command Petroleum, and with the development of the Ravva oil field, we have been at the forefront of the increased foreign activity. Over the last five years or so, we've been building a significant upstream presence in India. Our Indian position is the equivalent of about 135 North Sea Blocks-- I haven't quite worked out how many Gulf of Mexico Blocks that is. So, we have a very large upstream position. On the East Coast it is based on the Ravva oil field, and then two large licences in the Krishna-Godavari Basin, which is KG-06, of which we have 50%, and KG98/2, of which we have 100%, picked up in the new NELP in India last year. And then, on the West Coast of India, we have a 50-50 joint venture with Shell in Rajasthan, and then we have 75% of Block CBOS-2, where we've just recently announced the successful discovery of the Lakshmi gas field. What we've announced is on the order of 400 Bcf in the structure that we've discovered, which adds about 30% to our reserve base overnight. But what we are most excited by in this discovery is that we have a very large acreage position around it. We've also said that on an unrisked basis, we think that licence has, maybe, up to 2 Tcf of unrisked reserve potential. So, at the end of the year, we will be going back into that licence and drilling exploration and development wells. We are also planning an exploration well in Rajasthan, and then further exploration wells on KGO-6 and KG98/2. We see India as an exciting emerging market, and within the energy sector, we think there is a lot of potential in the upstream there. We were lucky enough to get in early, and to get a production base, and acreage, particularly with the 98-2 block which is essentially a deep water, at a time when people were seeing a $12 oil price environment and no reason, perhaps, to go into a new country. With Cairn already in India, we were able to bid in the bid round in that environment and, obviously, the turnaround in the oil prices since has made that look like quite an intelligent move. So in the next six months, the company is going to have a very exciting drilling programme, because it's highly focused on key Blocks with significant potential where we have big equity interests. Philosophically, we believe in taking large bets in areas where, if we're right, we can follow up behind our success because we've got the acreage base. My history and initial experience was in the early 1980s, when I was drilling perhaps as many as 200 wells a year in North America. And it taught me a basic golden rule that I keep in mind at all times in this business: "double the risk and halve the reward" of whatever the technical guys tell me, because you can be disappointed. But, if you can get into an area that has high potential, and you are successful, you can really leverage up your success on that. In the last couple of years, it's just been a difficult time for the whole industry. Cairn, however, was always in cash: we never had net debt; we had cash. And we were able to build from that base and actually look to expand our exploration position, and now, this year, to expand our exploration drilling activity dramatically.

TWST: How does the business break out, gas versus oil?

Mr. Gammell: We're about 50-50. We're well balanced, and I'm pleased to say that we're completely unhedged, and so we're benefiting from the strong product prices at the moment.

TWST: Where would you like to see Cairn Energy in three years?

Mr. Gammell: In three years' time, I hope that we have added very substantially to our reserve base, particularly in India. I think we have every opportunity to dramatically grow the reserve base and, hopefully, the underlying value, and, consequently, depending on market sentiment, the share price for shareholders. I fundamentally believe the skill base that Cairn has lies within its entrepreneurial team who look to find a competitive edge and really add their technical and commercial skills to put deals together and exploit opportunities. And then we will look to bring in added value through formation of partnerships to do developments, or selling of fields or other interests. I don't necessarily believe that Cairn wants to continue to grow into bigger versions of itself all the time, but may divest interests along the way. I think our skill base is probably at the front end, the entrepreneurial end, rather than necessarily in building one mighty empire. I believe in the virtual oil company as being very much the way forward with the new trends using e-commerce and the ability to access so much information. I think we're very focused on the areas where Cairn believes that it can add value and bring in added value partners to help us. Or, if there is an interest that has greater strategic value or financial value to a third party, we may sell that interest.

TWST: Could you tell us more about Cairn's competitive advantages? What else sets the company apart?

Mr. Gammell: I think, culturally, I always talk about our people taking brave pills. I think we're prepared to back ourselves in our own judgement and, if necessary, we will take 100% interest. For a small company currently capitalised at - I guess, we're now - about GBP250 million, we are prepared to take 100% interests. And, indeed, in CBOS-2, we had 45% of that licence, and we actually acquired an additional 30% interest last year to take us up to 75%, because we believed that it was a good prospect. Last year, we bought in about 12% of our shares, because we believed there was no better acquisition in the market that we could see in terms of producing opportunities than buying in our own position. So, I think the competitive edge that we have is very much our entrepreneurial background, having started originally as two people - encouraging people to take responsibility and backing them in a very much team-based approach. We are prepared to back our judgement and place perhaps larger chips on the table than maybe other people feel is prudent to do. I don't actually believe in the philosophy of spreading risk to the degree that you take 10% of 15 different prospects. Because I think if you follow the rule of doubling your risk and halving the reward, you tend to be disappointed on the one - or possibly two or three - that is successful, because you still may not have the ability to make up for the rest of the portfolio. We then also have the focus to be able to step up the speed of activity. But in assessing the risks, we look at the political risk, the commercial risk, and the technical risk. And often things that are perceived to be ugly, or are unattractive to other people, are sometimes where the opportunity is, if you can have the vision to be there at the front of a new province opening up. Our technical people got it right in Bangladesh, and they seem to be getting it right in India.

TWST: What major changes do you expect in your marketplace, or in your industry, over the next several years?

Mr. Gammell: I think e-commerce is going to have a dramatic impact on the industry in terms of the way that people do business. But I think, fundamentally, the consolidation movement that has been going on is at times a defensive movement, rather than a movement that is actually going to add value. I think from the perspective that we see, it's fundamentally about adding value, and we believe that we can primarily add value through the drill bit and by looking to see what is it that we think sets us apart should give us a particularly competitive edge. I think you've continued to see consolidation amongst the majors, and you've seen consolidation going down through the independents, and if you look at the London market, you'll find there are not many of the independents left. I think if you are going to be a publicly quoted independent, you've very much got to persuade your shareholder base that there's a very strong investment case for investing in you, as opposed to any other opportunities that they have. And I think for us, specifically, not being integrated, but being a pure upstream company is Cairn's strength. We must demonstrate that we are financially solid, but have the important opportunity to change values through the drill bit. And we think our particular niche is in exploration, and maybe our assessment of the risk-reward equation and opportunity. Now as you grow bigger, it becomes more difficult, and it's more difficult for any individual project to have a meaningful impact on the overall value of the company. And I think in Cairn's history over the years, you'll see that when that becomes the case, and we think that the capital base has grown so large that we don't think we have enough leverage for the key value-adding drill bit, we're prepared to divest some of our interests. So, I see the next three to five years as ones of continuing change. If we were to talk in three years time, you may find that the portfolio will have changed.

TWST: What percentage of gain in sales and earnings should investors expect from Cairn over the next several years?

Mr. Gammell: I think that's certainly one thing that we're very cautious about ever saying because we're so dependent on the product price. In Cairn's case, as you know, we currently are doing around 22,000 barrels a day, which is what would be expected looking out a year or two. But with new discoveries, your sales line can fundamentally change. If you bring on a new field like Lakshmi quickly, you can see a potentially significant increase. Because of these potentially significant swings, I can only really comfortably make project for this year. I think the market is expecting - given the strength of the oil price - substantial growth in our profits and cash flow for the year. Beyond that, it's certainly a difficult one to forecast because you can't forecast the future oil and gas price. But also, particularly from Cairn's perspective, we see sales and earnings as all about the value of any particular asset. So, I could be talking to you in two years time, and we could have sold a substantial asset for a number that I thought was greater than the DCF value - the cash flow going forward. I don't think we've set our targets purely on that basis. We are driven by ultimate value, and the asset value is either in our hands, the industry's hands, or a partner's hands.

TWST: How is your management team doing? Are they equipped to handle your ambitious goals?

Mr. Gammell: We've had some pretty dramatic changes in the management team, or the management structure, as a result of a refocusing of our business. Cairn identified the opportunity in Bangladesh. We were the operator of a very large position in Bangladesh on behalf of ourselves, Halliburton and Shell. We relinquished that day-to-day operation in Bangladesh just over a year ago. Eighteen months ago, Cairn had 50 people in Sydney as a result of a take-over of command. So, we had 50 people in Sydney. We had about 120 people in Edinburgh. We had 100 or so in Bangladesh. And then we had, maybe, 250 people in India. We no longer have an office in Sydney, so that's 50 people, unfortunately, that we had to lay off. We no longer operate our day-to-day operations in Bangladesh, so those 100 people actually transferred across to Shell. And our Head Office in Edinburgh has been reduced from about 120 to 50 over the last year. We have now suspended new venture activity and focused substantially on India, so we have transferred a number of people from Edinburgh into India, and grown that base from 250 to probably 300 today. So, in terms of management change, there have been some major changes, but I think the management team is very focused on where the individual can add most value to the business. Unfortunately, as a result of the downturn, and also refocusing the business there were a number of people that we let go along the way. But I think, talking to us today, I think we're as well-positioned, perhaps better positioned, than we've ever been, and we've been a public company since 1989, because we have a very substantial cash flow and no debt, together with a lot of exploration potential. Our budget is on the order of $70 million this year, of which, the majority of that is actually in exploration. So, there's a lot of activity happening this year.

TWST: Do you think your budget in the future will remain around $70 million?

Mr. Gammell: I think it may actually be larger as a result of the discovery at Lakshmi. We know we'll be looking at exploration and development. But, over the years, the numbers can fluctuate dramatically, because of the type of business that we are. We've put significant stakes into individual opportunities, and if the individual opportunity is successful, we have the business flexed in such a way that we can get right behind that particular opportunity is that has come good. And so, sitting here today, I can't tell you which of the four different exploration areas we will be drilling over the next six months is going to yield the fruit. The first one that we've drilled has come up with the goodies, and we think there's a good probability that we'll have additional success on that particular piece of acreage.

TWST: As CEO, where are you spending your time at Cairn now? What are you concentrating on?

Mr. Gammell: I spend a significant amount of my time looking at strategy and, really, developing and seeing through the vision of where I think the company should be and where we see the opportunities. We have made a major play in the Indian subcontinent, and we actually have the largest foreign position in India and Bangladesh as a combination. So, a lot of my time is spent going to India or going to Bangladesh, although a lot less than it was, because we're no longer the day-to-day operator in Bangladesh. But we're really focused on looking at the individual parts of the business and saying: Are these areas to which we can significantly add value? If not, have they got better value by being sold to some third party? So, I think the focus is very much making sure that we have the correct management team, that they are acutely focused on delivering results and performance in their areas of responsibility. I aim to look at the company as if I am up in a helicopter looking down and asking: Are we really spending our time where we can add most value to shareholders? I think the thing in an E&P company that is often forgotten is that we have very large capital spends, and anything you can do to actually enhance the chance of success of that capital spend is usually critical. So, when people talk about restructuring and reduction of overhead, that's often only one part of the jigsaw. That has short-term benefit, but in the long run, you have to make sure that your people actually are focused on creating the value. I also always think about if I'm spending $5 million or $10 million on drilling a well, where the probability is I'm going to write off that money, because the chances are, more often than not, you're going to be wrong in drilling that exploration well. Anything I can do to enhance the probability of making that successful is important, and that requires high quality technical people and the best possible science one can put in to something. But at the end of the day, it also requires people having a gut feeling and instinct and finding the guys that will be able find it.

TWST: What should long-term investors look at in reading your financials?

Mr. Gammell: We're broadly a GBP100 million turnover company this year. I think long-term investors, certainly, for this year, would reasonably expect - assuming the oil price stays where it is, or near there - significantly stronger earnings and cash flow. I think forecasting into 2001 is extremely difficult, because I can't be sure that we'll have the same asset base in 2001 as we have in 2000. If you have a style of management that is always critically looking at the individual value of any part of your business, you may decide that you're prepared to sell it, because you are reinvesting in another part of the business where you see higher growth. We see the fundamental growth or the acceleration of value in creating the opportunities, looking at the technology, the seismic, and the drilling the well. And once you are taking it on through into the development phase, we may decide at that point that that production has a value that may be more valuable to someone else than ourselves. We think the real creation is in that front end delivery. So, that's why I find it difficult to say. If, all things being equal, having made this discovery in India, which we hope to have on production next year, you would expect our production base is going to be stronger next year than it is this year. But in the absence of bringing something new on to production, Cairn is actually in the position where the developments are all fully funded and are on full production. You might say that the sails are full out. And there is nothing in the development hopper other than money going into exploration. That's changed as of two weeks ago, and now we'll have a significant amount going into the development hopper and then bringing on future production. But we're very keen, if we do get into the exploration success phase, to make sure that we do everything we possibly can to bring forward that production profile as quickly as possible, because you can lose a lot of value by just discovering something and then never developing it.

TWST: How do you feel about your current stock price?

Mr. Gammell: I'm pleased to see that our current stock price is showing some appreciation of our recent success in India. I think the sector as a whole, in the London market, has been affected by negative sentiment when oil prices were low. I think there have been one or two unfortunate corporate turnouts where people, in the long run, have seen that they've not made substantial value by being in the sector, and I think that's something that everybody who's involved in running oil and gas companies are very conscious of. The majors, which you know, are integrated, have had a better long run track record. The individual independents, over a period of time, have often destroyed value. And in Cairn's case, we've had periods in our history where Cairn USA's stock did 10 times, and in the London market. Cairn Energy's Plc stock multiplied 20 times. We were actually a $6 million market cap company in 1992. On the back of Bangladesh, we got to just over GBP1 billion. We're currently around GBP250 million. I can say from 1992 to now, from 6 million to 250 million is pretty good, but if you actually follow through the rights issues that have been made along the way, you're making money, but not a great deal of money. And what that tells you is that there tends to be a time to buy and a time to sell an oil and gas stock, dependent often on where the oil and gas prices are. Over the long run, the market gets it right. And I'm obviously more relaxed talking to you today than maybe I was three or four months ago, because there's beginning to be a bit more of a following for and appreciation of the fundamental assets in Cairn.

TWST: Congratulations on the find in India; that's great.

Mr. Gammell: Thank you. The thing about the find in India is the perspective, and to realise the materiality of the opportunities that we see in the Indian subcontinent. The Sangu gas field is greater than 1 Tcf of gas, and we're currently drilling deeper in that field at the moment. The Ravva oil field is a 250 million barrel oil field, and we think that we have prospects in the region of Ravva that could be as large. So, if you've got 100 million barrels of reserves in the Group and you have potential to drill structures of that size, and greater, then you have the potential for major reserve additions. We are drilling things that are of high materiality, and that's why we're excited about our prospects.

TWST: What two or three reasons would you give long-term investors to buy stock in Cairn now?

Mr. Gammell: I think, right now, we are very well supported by current cash flow and reserve base. We have a 12-13 year reserve life. We're trading on a pretty low cash flow multiple, and I think if you read any of the brokers reports on the London market, you'll see that more or less everyone has a buy rating on us, because they see us at a significant discount to asset value. More importantly, though, I think because management is very focused on delivering value, and because we think over the next six to nine months that we have a lot of opportunity to achieve success through the drill bit, which I think is the ultimate way that we create value, Cairn offers an excellent investment opportunity. At the same time, you have a proactive our management is prepared to downsize or sell assets if they think it's the interest of shareholders, rather than just to try and build a larger company for the sake of size. I do fundamentally believe that it is all about adding leverage to your equity base in creating value, and we are prepared to downsize or restructure if we think that's the most appropriate way to go. Investors that have known us over a period of time will have seen from our track record that we have done this a number of times and will continue to think about doing so again. If part of our business is no longer core, or we don't see that we can really create additional value, we'll dispose of that part of the business. We are a very pure exploration company that is in an exciting emerging market in India, and we really have a competitive edge. There are very few upstream players in India at the moment. There are a lot of downstream players coming into India, and we think those downstream players are going to need commodity, and we hope we're going to find if for them.

TWST: That's a great story. Is there anything I've missed?

Mr. Gammell: We've pretty much covered it. The key message in Cairn is that it is very much about trying to deliver value on specific opportunities that have taken quite a long time to gestate. Today we're sitting in a situation where we hope a number of such things will come through. The discovery that we've just made in India was evidence of the Cairn style, where we saw an opportunity to move in and drill a well quickly, before the monsoon period. We only got our offshore seismic in February, and we had a well drilled by early May. We move quickly if we see the opportunity.

TWST: Thank you.

BILL GAMMELL
Chief Executive Officer
50 Lothian Road
Edinburgh EH3 9BY
United Kingdom
Tel: +44 (0)131 475 3000
Fax: +44 (0)131 475 3030
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